How a Banking Panic Differs From a Banking Crisis

    The closing of three financial institutions in the past week has sent a sense of crisis through the financial world. Deposits are insured at FDIC institutions up to $250,000. Some accounts are many times this number. Venture capitalists (VCs) typically deposit in the hundreds of millions into banks, to be withdrawn as the funds are utilized. This was especially true of Silicon Valley Bank (SVB), a forty-year-old institution that made a name for itself catering to start ups and VC clients. SVB at last report had $211 billion in deposits. This was offset with a combination of loans to various firms and purchases of US Treasury securities. As interest rates climbed and customers drew down their balances, the bank needed more funds to meet withdrawals. The problem was the Treasury investments had gone down in value. SVB was advised by Goldman Sachs to sell off part of its bond portfolio at a loss to raise funds to meet customer withdrawals. This generated a $1.8 billion loss on a portfolio sale of $20 billion. In anticipation of this, Goldman also was arranging a stock sale to replenish the bank’s capital to replace the $1.8 billion. After the bond portfolio loss was made public the stock sale did not take place. There was a run on the bank as depositors demanded their funds. The bank could not liquidate assets, including loans, fast enough to meet the demand for deposits. The FDIC shut down the bank and took them over. Their stock, which peaked at over $700 a share in 2019, is now worthless. Goldman, who bought the bonds from the bank, made $100 million on the trade as interest rates declined with the government intervention. The speed of the bank’s fall is a product of the communications evolution they in part financed. The reasons are as old as banking itself. Banks fail for three reasons. The first is liquidity risk. Banks by nature take in deposits to make loans of some duration (usually three months to eight years). As interest rates rise, banks often cannot keep up with competition for interest rates on short-term funds. This is especially true of retail banks whose overhead in the form of branches, staff, etc. adds to their cost of operation. They normally pay this cost through obtaining deposits at low or no cost through the branches. As people go online and find higher yields, banks suffer outflows of funds which impacts their liquidity. The second reason is interest rate risk. In addition to the liquidity issues above, rising interest rates threaten banks who cannot raise their loan revenues in tandem with higher cost of funds. In times of low loan demand banks buy Treasury securities to make something off the deposits. If a bank incorrectly forecast interest rates, it could wind up (as SVB did) with losses on its bond purchases. These losses are sometimes not recorded on the assumption that the bonds will be held to maturity and will thus return to face value. However, if the bank needs to sell the bonds prior to maturity, the loss is recognized and charged against the capital of the institution. The third risk is systemic risk. This is the risk that a bank failure will trigger other bank closings. The poster child for this is the banking system in 1929, when regulators let banks go under until the situation got out of control. This caused a severe recession to become the Great Depression. The FDIC moved in and guaranteed all deposits of SVB regardless of size to ensure that there would not be a bank panic. They did this because they saw the bank’s demise as systemic. This was a bit ironic, as laws passed in 2018 increased the size of a bank considered systemic from $50 billion in deposits to $250 billion. At $212 billion, SVB was exempt. This law was passed at the behest of the regional banking lobby. Their members resented being put under the same regulatory burden as larger banks. At the same time, lobbyists reduced the amount of funds allocated to bank exams and compliance. Reducing enforcement of bank rules has the same effect as reducing IRS enforcement. SVB had no Chief Risk Officer for most of 2022. As a non-systemic bank, the role was not required. As normal in such a situation, there is a great deal of finger pointing. At minimum, the size limit for systemic banks will be reduced, perhaps back to $50 billion. The enforcement arm of the FDIC will be funded. At this writing, there does not appear to be major losses in the SVB loan portfolio beyond the bonds. Thus, the cost to the taxpayers will be minimal. Stockholders will be wiped out. Life will go on. The yin and yang of having regulations established in response to a crisis, only to be repealed some time later and then resurrected in the next crisis needs to stop. Regulations are written for a reason. While regulations need to be reviewed and revised periodically, this business of repeatedly closing the barn door after the horse escapes is crazy. It does nothing to build confidence in our banking system or the branch of government that oversees the same. Without the credit provided by banks, the economy grinds to a halt.   The demise of SVB has exposed the issues surrounding banking. Higher interest rates have led to deposit outflows, while static loan rates pressure profit margins on loans. Neither issue will be resolved soon. Banks that exist online with few or no branches will have a cost of funds advantage. That makes other lenders problematic. The Economy Economic activity continues apace. While corporate profits are being squeezed by higher expenses, especially for labor, revenues continue for most firms to be going up. New home construction has had the greatest gain in two years. One area to watch is the fall of the dollar. If the dollar continues to depreciate relative to foreign currencies, expect greater demand for goods made domestically. The constraint is the size of the workforce. The semiconductor industry has already said they cannot find the workers necessary to staff the new chip manufacturing plants, which are supposed to cost over $100 billion to build. Inflation Overlooked in the bank crisis is the fact that inflation, while down, is nowhere near the two percent rate banked on by the Federal Reserve. The best readings are around five percent currently. While this is down, it is not down enough to satisfy the Fed. A falling dollar will create another round of inflation, as imported goods will cost more to buy. Some people say the SVB implosion is shaking people’s confidence in the dollar as a world currency. Such a loss of faith can be inflationary as well. Interest Rates Pressure is being put on the Fed to pause the increases in the Fed Funds rate as a way of helping the banks. With inflation still running hot, this probably will not happen. Other banks should not expect the SVB treatment should they find themselves in trouble. Smaller banks in particular will continue under pressure, and all depositors should not expect to be made whole with every bank insolvency. There is about $1 trillion in bank deposits not covered by FDIC insurance due to their being more than the $250,000 limit. The Stock Market Stocks will rebound from the declines caused by the bank crisis. Aside from crypto investments, most sectors should do better going forward, at least in the short run. Once the sense of crisis has passed, the stock market will be faced with the same headwinds it had before the banks took over the headlines. Interest rates are going up. The labor force is not equal to the opportunities available. Business will be better in terms of revenues, but costs will be hard to contain. Profit growth will be difficult to come by. The pressure of higher interest rates will continue to assert itself. As consumers find outlets that provide 4-5 percent return on their cash, the case for long-term bond investing will be wanting unless long-term interest rates materially exceed that. Stocks will depend on the situation. With the demise of SVB, a prop for the tech sector has been removed. Expect the transition away from growth to value to continue. Warren M. Barnett, CFA March 20, 2023 Barnett & Company is a fee- only investment adviser registered with the U.S. Securities & Exchange Commission. Registration does not imply a particular level of skill or training. Barnett provides services designed with the investment and financial planning needs of individual and organizations in mind. For more information about the firm please visit our website, or please call Jessica at 423.756.0125
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To Reduce Inflation and Not Sink the Economy: Increase the Work Force

It should be obvious by now to everyone that increasing interest rates to slow the economy is not resulting in lower inflation. It is obvious to the Federal Reserve, who nevertheless continues to increase rates to kill the patient to make the procedure successful. The reason increasing interest rate increases are not working is inflation now is the result of a far different landscape than previous economies. Just one example: only about ten percent of new mortgages are variable rate which increases with an increase in prevailing interest rates. A decade ago, the number was forty percent. Having a fixed rate mortgage in this environment makes you immune from the effects of rising mortgages, unless you choose to move. The overall savings rate is higher, due in part to the stimulus payments but more to the changing demographics of the country. About twenty percent of the population is 65 or older. In 2005, the figure was closer to twelve percent. This is a group that is living off its capital by expending it. In effect the older retirees are acting collectively as a privatized version of the government stimulus program. At the same time, there remains 1.5-2.0 job openings for every person looking for work. The Fed has looked high and low for the supposed missing workers who disappeared after covid. It would be a safe bet at this point they are not coming back. Whether long covid, death, other disabilities, personal capital to live off, or whatever, the workers the Fed assumes can be enticed back to the work force does not seem to exist. Finally, there is another reality: the wages increases that have been paid through price increases to date have not put most people ahead of inflation. This implies that wage increases are set to accelerate unless more workers can be found. Workers can be found if the immigration system can be reformed to accommodate them. One proposal is for a worker visa for five years, subject to renewal. They would be distributed based on skills needed by domestic employers. Employers can interview workers in their home countries or otherwise outside the US. Smaller employers can have this done on a pooled basis by the Department of Employment Security in their state. If a person has a skill set in demand in the US for which there is a job vacancy, they can be hired by a domestic employer. They would be given a social security number; their wages would be taxed, and they would be required to contribute to Medicare and Social Security. As they would not have full citizenship, they could not apply for either retirement or retiree medical benefits. They would be covered by workers’ compensation. They would be paid at least the minimum wage. Any employer attempting to pay less than the minimum wage for employees would be faced with imprisonment. Should the worker be granted citizenship, trust fund contributions would be claimed retroactively. Any worker convicted of a crime would result in immediate deportation. Such a program could have several salutary effects. It could increase the labor force in a way that would be immediate and accretive. By increasing labor supply, it should reduce wage inflation. Additional workers could themselves be a source of economic growth. The workers would have the option of returning to their home country or becoming a US citizen after a period of time. Since only those who have skills in demand would be permitted to migrate, the issue of unemployed or unemployable migrants is addressed. Without this approach or something like it, the country’s economic fortunes likely set to dwindle. The population of the US is contracting. Consumer spending is slanted sixty percent towards services, which are far more labor-intensive than goods. Healthcare facilities are already experiencing profound shortages of personnel. Raising interest rates likely not address a worker shortage. Only more workers can do so. Thus, the economy may need less from the Federal Reserve and more from the Legislative and Executive Branches of government. Elected officials have shown a reluctance to take on an issue that may aggravate those whose vote they court. Perhaps if the issue were reframed as an economic one it might get more support. The Economy The economy grinds on, doing better than most expect and the Federal Reserve wants. Fourth quarter GDP has been revised to up one percent. This is almost five times more than previous readings. Even with a stronger number, there are indications that profit margins are narrowing for some companies. Strong wage growth must be paid regardless of revenue increases. The result is a squeeze in profits. This has been especially pronounced in very high paying jobs like technology, law, accounting, and consulting. Some are even saying this could be the first white collar recession as workers in these jobs are cut back due to lower sales growth and less generous venture capital funding. Inflation Inflation is becoming harder to explain away. Energy, the original engine of inflation this cycle, has been subdued at least for now. Food prices are now out of control as bird flu causes egg prices to increase seventy percent and any manner of produce is impacted by weather irregularities. Recently some countries have banned exports of onions. When food becomes scarce, people initially hoard it, aggravating the efforts to match up supply with demand. Interest Rates Any plausible scenario of interest rates declining has been shot down by the strong labor markets. Rates are headed higher and likely be high for longer than most previously envisioned. One interesting observation is those who are advocating the purchase of bonds. To make such a recommendation, one must assume that interest rates are peaking, inflation will go back to one to two percent per annum in short order and yields will decline in tandem. There is nothing on the horizon that seems to supports such a scenario. So far as an “inverted” yield curve being touted by many as predicting a recession and lower yields. (This is when short-term rates are higher than long-term rates.) A yield curve can also reassert a normal pattern by having long- term rates going significantly higher and short-term rates be unchanged. The Stock Market The gains recorded by the market so far this year seem to be a case of euphoria getting the better of fundamentals. While there are some industries that should do well this year like the airlines, in general there are several industries that would seem to be on thin ice. Tech firms have been rife with revenue disappointments. Electric utilities have been considered very conservative investments. However, most utilities have significant amounts of debt on their balance sheets that will be rolled over at sharply higher interest rates as time goes on. Couple this with the demand to fund new generating and transporting capacity to accommodate electric vehicles, most utilities could soon be petitioning for significant rate increases. At that point, electric rates become very political. Which is to say, not financially predictable. Warren M. Barnett, CFA February 28, 2023 Barnett & Company is a fee- only investment adviser registered with the U.S. Securities & Exchange Commission. Registration does not imply a particular level of skill or training. Barnett provides services designed with the investment and financial planning needs of individual and organizations in mind. For more information about the firm please visit our website, or please call Jessica at 423.756.0125
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Playing with the Country’s FICO Score: Possible Consequences of Debt Standoff

As of last Thursday, the United States Government reached the limit of its authority to borrow. While some evasive actions are being initiated by the Treasury Department to keep the government open and pay its obligations, these steps are expected to be exhausted sometime this summer and no later than Labor Day.  The United States is the only developed country in the world that puts a limit on its government’s ability to borrow. Other countries rely on the market for debt to dictate what their government can do. The United States Constitution (14th Amendment, Section 4) states the “The public debt of the United States, authorized by law...shall not be questioned”. Thus, Congress must dictate the amount of debt the country can assume. While less than the amount shouldered by other countries relative to the country’s Gross Domestic Product (GDP), the federal debt has been rising. The debt limit was raised three times during the Trump administration to accommodate the tax cuts implemented as well as the expense of taking on covid in a recession. There was no serious discussion as to need or whether to do so. Now that it needs to be raised for the first time in the Biden administration, Republicans who control the House of Representatives have gotten fiscal religion and have decided not to raise the debt limit without expenditure cuts in return.  The problem is that more than half of the Federal Budget consists of Social Security and Medicare payments. Another third or so is military expenditures. Thus, the ability to cut the budget is not there, unless payments to the elderly are reduced.  There is a second way to balance the budget. It would involve raising taxes on the wealthy and corporations. This in fact will automatically happen if the 2017 Trump tax cuts are not made permanent. When they were passed it was argued that the cuts would spur economic growth and the incremental tax income would pay for the cuts. They have been given ten years to bring this about. As this has not “happened”, it is expected that the cuts will sunset over the next four years. This will amount to an automatic tax increase of about $1 trillion per year if all reductions are allowed to expire.  A second way to reduce the deficit would be to fund Internal Revenue Service enforcement of tax laws. Based on the law passed last year, there will be an increase of $40 billion per year in tax receipts based on a formula that every incremental dollar of tax enforcement yields five dollars in revenue. The budget increase is for $8 billion per year over ten years. This differs from the $80 billion increase touted in the media. Republicans are against this, vowing to repeal the measure that may impact their largest donors. Our tax system is based on voluntary compliance backed by the ability to enforce the tax laws as necessary. If this system is not financially supported, then you have a situation like that of Greece or Brazil, where fewer and fewer people pay more taxes because evasion becomes a sport. Unless compliance is adequately funded, those who can afford to retain tax professionals delay or deny their payment, while those who cannot afford to challenge the government wind up paying their full tax liability. The IRS budget has been reduced systematically for years. This is not an expansion of enforcement so much as a restoration of the same.  The consequence of not funding the government will be dire. If the United States were to not honor its debts, the willingness to hold US Treasury securities will be called into question. As this country does not generate enough savings to fund all the debt required, the loss of foreign bond demand would be severe. It would also be the end of the dollar as the world’s reserve currency. Counties like China and Russia would very much like that. Finally, a default of debt payments would lead to higher interest rates for government paper. This would blow a hole in the budget. The reason interest expense has been stable as more debt was being issued for the past decade is due to the decline in the coupon rate on the debt. Reversing this due to our own conduct would be distressing.  The House of Representatives is known for political theater. It cannot be ascertained how serious the members of the House are in steering the government onto the fiscal rocks just to prove they can do it. The last time this happened in 2011, the United States Government lost its AAA bond rating. (It is now AA+). This time around we stand to lose a lot more.  The Economy  Economic activity, while slowing, has not contracted overall. There had been weakness in the indexes that track goods. Services and housing cost continue to be strong. There is now estimated to be a shortage of commercial airplanes for the next several years due to lost production from Covid. This translates into pricing power for the airlines, which means higher ticket prices.  The talk of layoffs is almost entirely in the technology sector. Such jobs are very well paying but also often locally concentrated. One does not hear of layoffs of plumbers or electricians.  Interest Rates  Forecasts abound of how interest rates will peak and then go down later this year. While this is the consensus, that does not make it right. The game of shutting down the government if a group of congressmen do not get their way has no upside from the standpoint of interest rates. A falling dollar would convince foreign investors that a higher interest rate will be needed to offset the potential for a lower return of principal in the foreign currency. The bottom line is for interest rates to go higher and stay high longer than the market is predicting.  Inflation  Inflation is expected to get a second wind from the falling dollar, which will make imported goods more expensive. More expensive imports give cover to domestic producers to hike prices.Since more people work in services than in the production of goods, higher wages will translate into inflation on this front as well. Rents are stabilizing, but from a high level.  The Stock Market  Stocks are going to be volatile. Some companies are going to see their margins squeezed by higher wages on one hand, and softening demand on the other. In truth, margins pre-covid had never been wider for most firms. With increases in labor and interest expenses increasing faster in some cases than revenues, there is not a lot of companies can do to offset. In general, the larger the labor force a company has relative to revenues the more potential for earnings disruption. With revenues moderating, there are not a lot of places for profits to go to escape being eaten up by expenses.    Warren M. Barnett, CFA January 23, 2023   Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!      
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Fearless Forecast 2023: You Can’t Go Home Again

Asheville, North Carolina holds a special place for the writer and native son Thomas Wolfe, whose 1940 novel’s title You Can’t Go Home Again is a fitting framing for investing in 2023. Many investors are trying to treat the events of 2022 as an aberration in the hope that 2023 returns us to the pre-covid era of cheap money, abundant credit, low inflation, and high security valuations. Such investors are destined to be disappointed. Start with some variables that will impact the year. First off is the war between Ukraine and Russia, a situation that did not exist prior to the end of February this year. How this situation resolves itself has implications beyond the conflict. If Russia prevails, it will probably be a prototype for Russia and other dictatorships to try similar moves elsewhere. One can see Taiwan becoming an Asian version of Ukraine. If Ukraine prevails, there will be little credibility for Vladimir Putin. Unfortunately, dictatorships have no clear line of succession. It is thus not obvious if his successor would be better or worse. Interest rates are on most investors’ minds. Unfortunately, their framing of the inflation situation is heavily influenced by the media, which is being fed a scenario where interest rates will go down with inflation. First, inflation shows no sign of declining to the rate of two percent which is the Federal Reserve’s stated goal. Second, the Fed intends to bring interest rates above the inflation rate and keep them there. Two percent inflation translates into a short-term rate of 3-4 percent, which is not that much off where they are now. The most recent reading of inflation put it at 7.8 percent year- over year. Even if inflation were to come down to five percent, it still implies higher interest rates from here. Betting on lower interest rates would not seem to be a good idea in 2023. The earnings of corporate America are expected to decline in 2023. The last of the stimulus funds are expected to be spent. Technology companies are rapidly laying off workers as revenues slow and profits plunge. While not large in number compared to the overall workforce, their average salary is typically several times higher than the average worker. Expect this to impact localities like San Francisco and Boston, as well as upper end consumer goods. Economists are already referring to this trend as a “white collar recession”. If so, it will be a first. Looking ahead to 2024, market soothsayers are saying that corporate profits will rebound. They will be aided by a more “normal” investment environment as well as the funding of infrastructure projects passed in 2020 and 2021. If the above forecast is correct, the recession and market decline should be shallow. If it is not there will be further turbulence in the overall indexes. One way to sidestep this is to not buy “the market” in the form of S & P 500 index funds, and instead focus on sectors and companies that will do well. For 2023 this would include industries such as health care, natural gas, and better managed companies even in out of favor industries. For example, Macy’s has been tested from its experiences before and during covid in ways that Nordstrom and Kohl’s have not. As for bonds, it is still too early to call a top. Even when one is formed, a bond fund will hold all kinds of issues that have declined in value. If one is too early, a portfolio loss can ensue. If correct on being elevated for a long time, there will be opportunities when and if interest rates decline. Interest rates will not decline like they did in the 1980s. Truth be known, even indexes can depend on a few stocks to carry them. As the current growth leadership is discredited (Meta (nee Facebook), Apple, Amazon, Netflix, Alphabet (nee Google), it will take a while for new leadership to form. At higher interest rates, investors are demanding a faster and higher return on their investment. The era of investing in firms that generate losses for years is ending. While the investing public focuses on the stock market, far more damage is being done in hedge funds and private equity. Because there is no index for private equity, data is replaced by rumor and gossip as to the value and health of the investments and sponsors. Many of these investments require low interest rates to compensate for the fees being assessed by the general partner. Sometimes these fees ran to five percent of revenues from the investments, plus additional fees assessed to the investors. As the value of the investment is estimated by appraisal, it is a lagging indicator both on the way up as well as on the way down. These investments were sold to pensions and endowments and “qualified investors” as being “non-correlated” with marketable investments. If falling like a rock qualifies as non- correlated, their worth has been proven. Much of the investing public has been sold on the merits of a portfolio of 60 percent stocks, 40 percent bonds. In October, BofA Global Research noted that to date this year the “60/40” approach has generated its largest loss since 1937. While the magnitude of the loss may be surprising, the existence of the loss should not be. Interest rates have been forecast to rise for years. Portfolio management is not a bakery where various recipes get you different returns over time. The world is more sophisticated and evolving than that. Investment approaches should be the same. The Economy Economic activity, while slowing, continues to be positive. This is a source of consternation to the Fed, who is trying to reduce inflation by increasing interest rates. For the reason for this, one must analyze the percentage of people working at a given age. The data shows that below the age of 55 work force participation is back to pre-covid levels. Above 55 it is 5-10 percent below pre-covid. The reason for this is two-fold. Older workers had high balances in their 401K accounts pre-covid and decided to retire rather than play Russian roulette with their health in the workplace. Remember that this was the age group that lost the greatest number of contemporaries to the pandemic. It also suffers most from “long covid”, an after effect of covid which renders some workers disabled. The second reason is the lack of immigration policies to replace these workers. As a work force shrinks, the ability to pressure it with interest rates becomes less effective. Pressuring fewer workers with higher interest rates results in higher wages. Due to the population demographics, the pre-retirement group (55-65) is not quite twice the size of the 25-35-year-old workers. Thus, the withdrawal of pre-retirees from the workforce has been proportionately more pronounced in terms of economic capacity and wage inflation. Inflation Inflation is forecast to decline this year from last. How much is up for discussion. The original drivers of inflation were work force shrinkage, energy price spike from Russia and its allies, the sale of the Treasury’s bond portfolio (known as quantitative tightening) and various disasters ranging from food inflation abroad to weather at home. In 2023 there may be a new element: a falling dollar. The dollar’s strength has been multi-year. At this point nothing is prepared to challenge it. However, as other nation’s raise their interest rates, the US will need to do the same to keep up. Otherwise,there will not be enough foreign buyers for US debt, which is a prescription for dollar depreciation. Since most all international transactions are denominated in US dollars, a decline in the dollar will help foreign countries at the expense of the US by increasing the cost of imported items in dollars but less in terms of other currencies. Interest Rates Interest rates have staged a mini rally of late on the expectation that a 50-basis point increase by the Federal Reserve Wednesday is somehow a harbinger of lower rates to come. Don’t believe a word of it. For starters, the Fed has not ruled out additional increases going forward. The difference between three 50-point increases and two 75-point increases is one of timing. So long as the Fed believes that interest rate increases will reel in inflation they will continue. There is a school of thought that believes that higher interest rates will not reduce inflation so long as inflation is driven by restrictions in supply rather than excess demand. For supply inflation, steps like raising the minimum down payment on credit items including homes and balancing the federal budget would do more to quinch inflation than increasing the cost of money. There is also the need to keep the value of the dollar elevated, mentioned above. The Stock Market Stocks presumably discount the future, so the shape of 2024 will have an impact on their 2023 valuation. More currently, stocks are under pressure from reducing earnings forecast as well as competition from short-term investments like money market funds. Value stocks have outperformed growth stocks for about 18 months now. There is not a lot to change that on the horizon. What one must watch for is the shifting definition of value. Utilities are value stalwarts. They have as a group had a good run this year but have historically low yields, pushing most out of the attractive investment column. With the cost of electric car generation and grid upgrading on the horizon, they may soon be users of capital rather than distributors. When utilities must raise capital, they become political footballs.   Warren M. Barnett, CFA December 13, 2022   Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!      
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“Fortune Favors the Bold” But Not the Gullible: The Ongoing Bitcoin Implosion

The current bankruptcy of bitcoin exchange FTX is sending shockwaves throughout the bitcoin industry. Billions of dollars of bitcoin investments cannot be accounted for. Celebrities like Tom Brady and Matt Damon have been exposed as paid hacks who sold their popularity for compensated endorsements. Most of the transactions occurred outside the US, making SEC oversight impossible. How much and how little were told to the investors in bitcoins is a matter of speculation. Their losses unfortunately are real. Earlier this month the FTX exchange, run by a thirty-year-old named Sam Bankman-Fried, sought bankruptcy protection. About $8 billion in prior stated assets have disappeared. It seemed Mr. Bankman-Fried used the clients funds deposited in his exchange to buy bitcoins to instead fund his personal hedge fund, Alameda Research, as well as his lifestyle in the Bahamas. Those of us who lived through the Dot Com era will recognize Mr. Bankman-Fried’s modus operandi. He would feign indifference as to the intent of the large venture capital firm to commit funds. He would impose a deadline for investing. He prepared incomplete or bogus financial statements. Investors into his firm could either meet the deadline or move on. Very large firms like Sequoia Investments and the Ontario Teachers Union signed on. While their investments are likely worthless, they are large enough that an investment in FTX is more an embarrassment than a crisis. Investors in the bitcoins that FTX offered to sell tell a different story. These were people who did not understand the nature of their investment, nor the conflict of interest in having an investment held by the same firm that sold it. Their investments individually were in the range of $500 to $100,000. Collectively their sums totaled in the billions. They are for the most part wiped out as well. To get the small bitcoin investors into the tent, industry advocates recruited stars and sports figures to push the investments onto to the public. Never mind the paid endorsers knew little more than the public in terms of bitcoin’s investment appeal. Some endorsers had invested early on and assumed the party would go on forever. Matt Damon released a commercial for bitcoin investing (“Fortune Favors the Bold”) at the high-water mark for bitcoin valuations. Their value has declined about 75% from its peak. On their merits, bitcoins are a nebulous investment. The United States dollar is backed by the US Treasury. The British Pound is backed by the Bank of England. Who backs bitcoin, the Wizard of Oz? Still, millions invested in bitcoins due to their hype of promised returns, fear of missing out, peer pressure (especially on the internet and social media), an ignorance of history and a lack of critical thinking. Bitcoins and their technology that made them possible, blockchain, first appeared fourteen years ago. The appeal of bitcoins first was apprised by those of libertarian disposition, who saw bitcoins as a way of circumventing the government’s ability to track transactions using that government’s currency. The idea was to permit income and assets to be transferred without government oversight. In time a criminal element was attracted, first for the ability to transfer assts, then for the ability scam investors with a vehicle that could be promoted online while operated outside the US. This last point is especially important. If bitcoins had been promoted by a domestic organization, disclaimers such as “Not insured/ May lose value” would have been required. Since the bitcoin custodians and transactions were outside the US, no warning was necessary. As usual for such a situation, politicians are calling for industry regulation and classifying bitcoins as investments. Such a designation would put bitcoin purchases and sales under the auspices of the SEC and by extension the IRS. From there, regulation as to their promotion and transparency would follow. It is an open question whether bitcoins could survive as an investment in such an environment. All current investors in bitcoins want is for them to go up. The reason why is not important. When they stop going up, those looking for a fast return will go elsewhere. It is also a given that movie stars and sports celebrities will think again before lending their name and reputation to something they know not of. The public will soon forget the endorsements. Those who lost money perhaps because of them will take longer. No doubt there will be more blow ups and bankruptcies of bitcoin firms. So far, the effect on more established markets is minimal. That may change if losses among investors mount and stocks and bonds must be liquidated to make margin calls. The Economy With ocean shipping now normalized, it appears that the economy is slowing at an accelerating rate. Some of this is inventory digestion, as items ordered earlier or perhaps double-ordered arrive. Current orders are deferred until inventory normalizes. Fed Ex Ground announced that they have started furloughs of trucks and employees. Coming a month before Christmas, the cutbacks are unheard of for this time of year. Some believe this reflects less an overall slowdown and more of a contraction of e-commerce after years of explosive growth. Interest Rates After the last rate hike, the consensus seems to be for smaller hikes going forward. There is no talk yet for interest rate decreases. Mortgage rates seem to have fallen below six percent this past week, as demand for mortgage applications contracts. The housing market is seeking to normalize at a lower price level to accommodate higher interest expenses. Tightening of funds can be seen in the higher interest rates offered on Certificates of Deposit. It is assumed that the government bond portfolio runoff is proceeding apace. Inflation News about inflation should be improving as we lap the increases of a year ago. Even if inflation continues, the rate of gain should subside. Food bills remain elevated as a drought on the Mississippi restricts barge traffic. Housing costs are still high but not increasing as housing prices moderate and rents increases are curtailed. The Stock Market The November-January time of year tends to be good for stocks overall, as most companiesare on calendar years. The new year means a new set of earnings forecasts that tend to move stocks higher. Possible disruptions to this outlook will be the threat by the new House leadership to prevent raising the National Debt ceiling, jeopardizing Medicare, Social Security, and the country’s bond rating in the process. For this reason, it is expected that the debt increase issue will be taken up by the lame duck session of Congress prior to the next session being installed in January. Other political disruptions could come from funding for Ukraine. The Republican House leadership seems to be critical of the amounts spent, while advocates of funding Ukraine speak of the parallels between the situation there and Czechoslovakia in 1938. To the extent the parallel holds, it is better and cheaper for the US to engage in a proxy war there rather than one in Europe or the Eastern US.   Warren M. Barnett, CFA November 22, 2022   Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!      
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Is the Growth Stock Correction Over? Not Yet

With the sale of Twitter to Elon Musk last week, a syndicate of banks had previously offered to loan Mr. Musk $13 billion to help pay for the $44 billion deal. The intentions of the banks were to turn around and sell the debt to the investing public as bonds underwritten by the banks who participated in the loan. It will be some time before the banks issue Twitter bonds. As of this writing, the pricing action in the market for non-investment grade debt such as Twitter is non-existent. Investment banks are holding on to the paper that they could sell to the public at this time only at a loss. Speculation currently puts the loans at 90-95 percent of face value. This would mean that the banks would lose $650 million to $1.3 billion by selling Twitter bonds to the public. The problem with the sale of Twitter debt has come on the heels of similar situations with Citrix Systems (an internet security firm) and Neilson PLC, the audience rating company. In each case the investment bankers could be on the hook for $500 million in debt losses each if the banks went ahead and issued bonds after each firm went private. The funds were needed to purchase the public stock. Having debt held by banks to not be sold to third parties is ominous for two reasons. First, it restricts banks from doing more deals should the debt not be off-loaded to others. Second, if the regulators sense that the debt is not worth face value, the reduction in value would be a hit to the bank’s capital position. This is currently the case of Credit Suisse, a Swiss bank that took several losses from financing hedge funds. They are selling off divisions and trying to attract capital from the middle east in a bid to stay in regulators’ good graces. Debt buyers are reluctant to assume the obligations of former growth companies. This would suggest the return to a stock market where growth names rule the market is wishful thinking. The performance of Meta Platforms (nee Facebook) falling 20 percent in a day last week would suggest some degree of panic is beginning to set in among its long-term holders. Add to this list the names of Amazon, Netflix, and Alphabet (nee Google), all down 35-50 percent or more from their highs set last year, and one begins to detect a pattern. The common thread of all these stocks is the belief that their above-market growth rate would go on forever. That never pans out. Eventually a company’s rate of growth begins to approach that of the economy in which it operates. Other impediments to growth beyond size are rising interest rates and an economic downturn. While people buy growth stocks on the assumption that they will be above the economic cycle, at some point a company becomes so large that it is impossible to avoid the economy’s pull. Can a growth stock that led the stock market cycle lead again? Not likely. Studies have shown that there is a less than on in five chance the leaders of one market advance will lead the next upturn. The reason for this is simple. A new company or concept is not constrained by relationships to real world factors like interest rates or the limits of its growth. Once those factors are established, more sober analysis can be conducted. A good case study of this is the auto industry. At one point Tesla was valued at more than all the domestic car companies combined. This valuation came in spite of making only a small fraction of the number of cars. With GM, Ford and others now producing electric vehicles, Tesla looks more like a car company and less like a hot concept. How long does it take for another hot concept to introduce itself? Sometimes it can take a while. After the market declines in 1973-74, it took until 1982 for the large stocks to start notching gains. Until then they basically treaded water for eight years while stocks of smaller companies went up by a factor of four. Like today, higher interest rates and inflation were factors. Also, smaller stocks represented better value in 1973, after a market driven up by the “Nifty Fifty” large company mindset from 1962-72. Everything old is new again as a concept. It may not be as an investment. The Economy As economic contractions go, this has been the mildest so far on record. Consumers have spent their way through it with aplomb, keeping employment demand elevated in the process. Layoffs so far seem to be concentrated in the technology sector. Lesser skilled jobs still have a ratio of two openings for every candidate. While the housing slowdown should change this, so far this has been a white-collar recession. Of greater concern is the paucity of capital spending. Aside from the government’s efforts at expanding the semiconductor and renewable energy industries, companies are not making the investments needed to add jobs and expand the economy. Part of this is due to the lack of workers, which is in turn a function of the restrictions made by the government’s immigration policies. Unless this is addressed, the idea of firms retuning offshore production to the US will be a pipe dream. Inflation Inflation is scheduled to become more manageable as comparisons are made to the same month of the prior year. Inflation continues to be a world-wide phenomenon. Prices have increased in most countries due to economic disruptions caused by the lock down policy in China as well as the Russian war with Ukraine. Transportation is beginning to normalize which will be deflationary. Interest Rates With the deceleration in the rate of inflation, interest rates should moderate their advance. The issue is whether inflation will moderate enough to permit interest rates to be reduced. At this point a reduction in interest rates does not seem to be in the cards. A lack of interest rate reversal would be a blow to Modern Monetary Theory (MMT), which believes that so much capital exists in the form of retirement accounts and the like that interest rates will be negative (that is, below inflation) for the foreseeable future. MMT did not account for the Federal Reserve’s bond buying program or its subsequent reversal. In order to keep inflation in check, interest rates have to be above the inflation rate. For this reason, it is not forecast that interest rates will decline any time in the near future. The Stock Market Stocks have scored a large rally in October. This rally would have been even more impressive save for the collapse in technology in the same time frame. While some people are predicting a market rally after the mid-term elections, it is not expected to be the basis of another sustained market advance. The pressure of higher interest rates and tighter lending standards may provoke another financial crisis which the market is not now anticipating. The best stock market strategy is to keep aware of earnings forecasts and buy what is out of favor. Do not chase rallies that do not have foundations. Be ready to sell when appropriate.   Warren M. Barnett, CFA October 31, 2022   Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!        
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Perception vs. Reality. Why Bonds are Not a Safe Haven

Advocates of formulaic investing along the lines of 60 percent stocks, 40 percent bonds are not doing so well these days. Year to date, bond indexes are down about 13 percent. This is the second consecutive year of negative returns from fixed income. While this may be better than the twenty percent decline in stock indexes, it is still shocking to those who advocate asset allocation as the be and end all of investment management. Over extended periods of time bonds have lower variability of returns. This has been translated by some as being less risky. Yet buying almost any debt of medium to long term in the face of rising interest rates seems a curious way to diversify. Higher interest rates mean loss of value for an instrument that pays periodically and returns principle at maturity. The longer the time to maturity, the greater the potential loss of value. While such losses in principle can be recouped if the bond is held to maturity, the purchasing power of the funds returned can be less than when they were invested. If one is invested in a bond, ETF or mutual fund, the participant has no control of a decision to sell the bonds in the portfolio, locking in the loss in the process. Should there be material redemptions from the bond fund, liquidating losses cannot be avoided. Ah, but you say that stocks, while posting higher returns over time, have higher variability of returns and thus must be riskier than bonds, correct? Not really. Stocks can raise dividends, which acts as an inflation hedge. They can buy back stock, which can improve the value of the remaining shares. The company they represent often can raise prices, which funds the rising dividends. Bonds, which are contractual obligations to repay money, typically have none of the features of stocks. Bonds have had a very well forty-year run since the days of Paul Volcker (1979). Then interest rates soared to over thirteen percent, to the post-2008 period, when interest rates came close to zero. Since companies benefitted from falling interest expenses favorably influencing corporate profits, stocks did well in tandem with bonds during this time frame. Bond investors also did well, as falling interest rates made older bonds worth more because they paid more than subsequent issues. The future will not look like the past. With soaring inflation world-wide, interest rates will rise until there is again a real (after inflation) cost to borrowing. While this may cause economic dislocation in the short run, the expectation of interest rates returning to their lows is wishful thinking. As other countries are swept along in the increasing cost of money, look for lower economic growth world- wide going forward. Add to this the loss of trust between countries caused in part by the pandemic, and a lot of the benefits of free trade become history. More recent investors see this as the end of an era. Those of more advanced age see a return to an earlier time. Six percent mortgages were common as recently as the 1990s. Even in the Great Depression of the 1930s, government bonds seldom went below four percent at issuance. As for international trade: the economic philosophy of comparative advantage, where each country would make what they were best at depended on a rational world. The image of such a world was destroyed by Russia’s invasion of Ukraine and China’s willingness to end relationships over Taiwan. Russia’s willingness to disrupt its principal exports of oil, gas and gold for territory shows how countries can subsume economic attainment for political influence. Both countries also found the creation of external threats a convenient distraction from the shortcomings of those in power. Neither of these events are economically rational, yet they do exist The next shoe to drop will probably be currency. As of now, the value of the US dollar relative to the currency of most other countries is strong, fueled by foreign investors buying dollars to acquire US dollar bonds with their high risk-adjusted interest rates. As other countries raise interest rates the US dollar should decline in value. A decline in the dollar would cheer on other nations who feel that it is US interest rates that are disrupting their own economies. If the US dollar does fall, it would have an immediate domestic inflationary impact which could prolong the elevated interest rates currently witnessed. Imports would cost more as they would require more US dollars to buy. The Economy Economic activity is slowing but not yet negative. Ironically, most of the layoffs in the economy to date are in the technology and management ranks. Economists are wondering if this will be the first white-collar recession. Blue collar jobs still have two openings for each applicant. Many companies are coping with sharply higher inventories as sales stalled out in May and June and have not resumed. Clothing vendors seem to be especially hard hit, as deep discounts are being required to move merchandise before it goes out of fashion. Supply chain issues seem to be getting a bit better. Ports are being streamlined to operate more productively. Inflation Inflation is slowly coming down. We are close to lapping the upsurge in prices of a year ago. Housing is a continued hot spot, as is transportation. The Federal Reserve has stated that they will keep raising interest rates until the cost of borrowing exceeds the inflation rate. Their goal is to reduce inflation to two percent per year. The consensus currently is for the Fed to raise interest rates to 4.4 percent and keep them there until sometime between late 2023 to 2025. Interest Rates To acknowledge that interest rates are going up is to state the obvious. The key issue is how high they will go and for how long. Assuming the goal is 4.4 percent, this could be attained by year end. How long it will be required to stay at this level is anyone’s guess. There is some speculation that a major event like a large bank failure or a currency crash would compel the Fed to relax interest rates earlier. It does not appear that many are banking on such a scenario. The Stock Market Stocks are undergoing a rotation. Shares of companies that have good prospects of raising dividends seem to be the best positioned. Companies in industries where competition is rising may have sub-par returns. This would seem to include most of technology. Going forward, the cash return component in the form of dividends will be critical to returns on stock investments. Stocks that do not pay a dividend will have a high bar to clear compared to the recent past. This also includes stocks that do not earn their dividend as it will be assumed that such dividends will be reduced or eliminated at some point.   Warren M. Barnett, CFA September 27, 2022   Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!        
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What happens to stocks when interest rates rise? A historical pattern gives us a clue

End of an Era: Powell Channels Paul Volcker Like today, in 1979 the perception was that inflation was out of control.  The hapless administration of G. William Miller at the Federal Reserve had left its reputation for control of the purchasing power of the US Dollar in tatters.  Every time Miller would have the Fed increase interest rates (gradually, so as not to trigger a recession), the inflation rate would go higher.  Tourists going to Europe that summer were shocked to find that their American money was not wanted, such was the degree of fear in the inflation rate of the US being out of control.  The domestic currency was treated as in the category of a banana republic. In order to shore up the credibility of the Fed, then President Jimmy Carter appointed Paul Volcker as chairman of the Federal Reserve.  Volcker immediately abandoned his predecessor’s policy of “gradualism” in raising interest rates to have them go up by leaps to get ahead of inflation.  At one point the prime rate charged by banks to their best clients briefly reached 22 percent.  Such high interest rates effectively halted the inflation mindset that was gripping the country by making speculation in assets so expensive people did not buy beyond what they did not need.  While everyone was in agreement that interest rates would decline, no one knew when or by how much.   Today the country is in the grip of a similar sense of inflationary fever.  The events of the past thirteen years, when the Federal Reserve willingly and deliberately set interest rates below the inflation rate, brought a decade of prosperity at the expense of savers, who have received a pittance for their savings.  These meager returns on cash and equivalents drove millions of investors into the stock market who otherwise would not have.  It also provided the kindling for the current inflation fire the Fed is trying to put out. Jerome Powell, in his eight-minute speech at Jackson Hole, Wyoming last Friday, put the world on notice that business as usual would change.  Exactly how much would depend on the inflation rate going into 2023, but it appears the Fed will again use the inflation rate to benchmark the interest rate.   This has not been done for quite some time.   The instruments for raising interest rates will be both the interest rate set by the Federal Reserve to charge banks for funds as well as the liquidation of the Federal Reserves’ bond portfolio which now totals almost $9 trillion.  The vast majority of the portfolio’s holdings are government bonds and mortgage pass-through certificates.  By letting the interest and principal payments not be reinvested, it is estimated that the portfolio can be reduced by $200 billion per quarter.  The effect of not reinvesting the cash flows will be a contraction in the nation’s money supply. A branch of economics once headed by Milton Friedman believes that inflation is the result of too much money in circulation.  This branch of economics, called monetarism, believes that inflation follows the direction of the amount money in circulation with a thirteen-month lag.  If this is true, then inflation should begin to decline materially by next year.   The effect on investments from higher interest rates will likely be profound.  If money market fund rates were to return to the range of four to five percent, a significant source of public demand for stocks will be diverted to a safer and less volatile venue.  Such a rate would put pressure on banks to increase their loan rates to compensate for the rising interest rates on deposits.  All risk assets would be impacted, especially those which need low interest rates to generate returns.  Less liquid investments like private equity and venture capital will be under renewed scrutiny given a higher risk-free benchmark. Cash returns will likely become more prominent in investor’s thinking. This would adversely impact firms that need capital to expand and have no track record for repayment.   An inability to generate cash returns will be less tolerated.   Finally, this higher interest rate environment will impact the largest creditor of all, the US Government.  It is estimated that every one percent increase in interest eventually costs the Federal Budget $300 billion a year in higher outflows.  Lots of changes to go around. How does inflation effect businesses? So far, the economic data has largely not felt the impact of higher interest rates.  Increases thus far have been less that the inflation rate, being of little account. That is likely about to change.  Cyclical industries like housing and transportation are experiencing sharp contractions in demand.  Buyers are cancelling housing contracts, even if this means walking away from deposits, for fear of overpaying after the recent runup in prices.  Computer semiconductor chips have gone from shortage to surplus for many applications. Retailers are grappling with ballooning inventory that needs to be moved before becoming stale.   Causes and effects of inflation Inflation for the past several months has been the product of supply chain disruptions caused chiefly by the lockdowns in China. Energy inflation from the war in Ukraine. Domestic stimulus from the administration’s efforts to prevent the country from stalling out during our own Covid lockdown. Of these three factors, only domestic stimulus has been eliminated going forward.  Energy demand, especially for natural gas, is focused to be higher going forward.  China has yet to formally change its Covid policy of disrupting entire cities and regions to prevent its spread. Finally, it has to be acknowledged that inflation is a world-wide phenomenon.  While people tend to treat inflation locally, it is actually in this instance an international problem.  It may thus require an international solution. Interest rates. What’s next? Interest rates are due to go up.  How much depends on the trajectory of inflation which in turn depends on international events and the response of other countries.  Should US interest rates rise too much they will attract funds from other countries, complicating their own economies. Relationship between interest rates and stock prices A higher inflation environment will put growth stocks under even more pressure, which is to say their declines since last summer are set to accelerate. The sharp correction of last Friday will probably have further to go.  Out of it shall come a new upturn based on cash returns and the ability to increase dividends going forward. Energy, especially natural gas, has been a bright spot.  Pharmaceuticals have also been strong, with firms with specific strategies being the eventual winners. The chief question for investors is whether current holdings should be held to the next market upturn, added to, or eliminated.  Bear in mind that fewer than one in five leaders of a given market survive to lead the next strong market.  Those invested in packaged products like index funds in effect have the market making their investment decisions for them.   Warren M. Barnett, CFA August 29, 2022     Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!
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Oil Refinery Economics: How a Shortage of Refineries Cause an Increase In Gas Prices

Economics 101 - Law of Supply and Demand: legislating oil refineries decreases supply With the exception of a small refinery launched in North Dakota in 2014, no new oil refineries have been built in the United States since 1976. In 1972, Richard Nixon formed the Environmental Protection Agency (EPA), charged with restoring the environment to its "original pristine state." As oil refineries are material polluters, the EPA did not take kindly to their existence. As a result, oil refining joined a list of any number of industries that exported their pollution by building plants abroad and taking factory jobs with them.  While the usual reason for outsourcing was cheaper labor, often such rationale was an excuse to escape American environmental laws. For the average company, direct labor costs come to less than five percent of the cost of production. Factors such as cost of transportation, inputs, taxes, and environmental regulation are usually far more significant factors in the price of producing an item. These elements of refinery economics have a huge impact on what we pay for gas. Marry this with the NIMBY (Not in my backyard) movement, and you have an impetus not to build oil refineries in America.  Oil companies have spent the past half-century increasing the efficiency of existing plants because of local opposition to new facilities. This increase can only go so far on the limited amount of land. In 2019, the oil industry shut down about five percent of domestic refining capacity as demand fell off a cliff in the early days of COVID. Most of the closings were among smaller refineries lacking economies of scale to be as efficient as the larger facilities. That capacity is probably gone forever.  Economics 201 – Finding equilibrium: A decrease in refineries’ supply leads to an increase in price The truth is that restarting a refinery is not easy and takes a good bit of time and money. Any crude oil left in the pipelines turns into sludge after a while. Restarting a refinery requires that most pipes be dismantled, cleaned out, and reassembled. In addition, there is the matter of finding workers to staff the facility, most of whom have retired with the shutdown. Petroleum engineers are highly skilled and not easy to come by.  The position of the Federal Government on this issue is, at best, inconsistent. It can best be described as someone trying to drive with a foot on the accelerator and the brake simultaneously. On the one hand, the President accuses "big oil" of profiteering by letting prices get too high and threatens the industry with an excess profits tax in the manner of Jimmy Carter in an earlier era. On the other hand, the government wants the industry to spend more to expand production (including refining production), including building the refineries that the EPA likes to cite.  The fact of the matter is that, with a few exceptions, all net new refining capacity in the world has been concentrated in four countries: China, India, Russia, and Saudi Arabia. Russia is off limits due to Ukraine, and India's capacity is almost entirely spoken for by its own economic growth. Saudi Arabia's new refining projects are only now coming on stream. Output has primarily been earmarked for Europe to replace Russian jet fuel and diesel. China has excess capacity due to its COVID lockdowns. It would perhaps be asking too much to expect them to help an American administration that cites them for human rights violations every chance it gets.   Then there is the government's love affair with electric vehicles (EV). There is not only a lack of electrical capacity but also a grid system to deliver the electricity where it needs to go; the government promotes the EV as the car of the future. The total vehicle market is mature. EV will need to take market share from gasoline and diesel vehicles to succeed. A new refinery requires forecasting profits 15-20 years out. How can an oil executive do so when the government actively promotes the industry's demise with tax credits for EV purchases?  A final note: LyondellBasell Industries operates one of the country's largest refineries in Houston, Texas. They have announced they would like to exit the refining business, buying feedstocks from others rather than making the raw materials themselves. The problem is that no buyers have come forward. The company has announced that they will shut the refinery down if they have no buyer by the end of 2023. LyondellBasell makes about two percent of the gasoline refined in the United States.   The Economy: Two key factors for recession Economic activity has remained strong as a shrinking workforce continues to meet strong demand in most areas. Unemployment has stayed stable, and wage growth has proceeded apace. Thus, two recession factors, increasing unemployment, and falling wages are not present.  Both residential and non-residential construction is due to expand. Housing has not seen the present demand gap since the end of World War II. Infrastructure is expected to get a boost from Federal Programs. Auto productions need to accommodate almost two years of pent-up demand due to the semiconductor chip shortage. Any demand decline won’t be until 2023, if that.  Inflation: What is affected by inflation  Inflation continues to be skewed to food and medical care, which fall most on the lower economic classes. The good news is that we are close to lapping the increases of the past year. Once this is done and inflation no longer continues at its original trajectory, we should see a decline in the inflation rate. My best guess at this point is three to four percent year over year by the fourth quarter.  For all the complaints about inflation, much of the effect of prices of imports has been blunted by the strength of the dollar relative to foreign currencies. As it takes more Euro, Pound, etc., to acquire a given number of US dollars, domestic buyers are rewarded with better prices than previously. Just ask any tourist traveling to Europe. This also means countries with weaker currencies must pay more for dollars than previously. This is one of the causes of domestic unrest in many parts of the world.  Interest Rates: All inflation isn’t bad Interest rates are destined to go higher. This is due to establishing an interest rate higher than the forecast inflation rate of 4-5 percent.   High-interest rates are also needed to continue to attract foreign funds into the US to maintain a strong dollar. If the dollar were to fall, the US would effectively be importing other countries' inflation.    The Stock Market: It’s a waiting game As usual, the market is being pulled in several directions. On the one hand, the strength of the domestic economy would argue for its appreciation. Offsetting this is the fact that not all stocks that were bid up in the last upswing have come back to earth. The cryptocurrency mania is also a mitigating factor and will continue to be so until it flames out. Companies in need of borrowing funds to expand are especially vulnerable.  Price corrections have, in some cases, been pronounced. So long as you do not need to sell, you can wait and pick up bargains while waiting for more rational minds to assert themselves.   Warren M. Barnett, CFA July 26, 2022     Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!
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